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Thursday, December 17, 2009

Does Morgan Stanley "Walking Away" from CRE Contribute to Strategic Defaults?

by Calculated Risk on 12/17/2009 10:59:00 AM

From Bloomberg: Morgan Stanley to Give Up 5 San Francisco Towers Bought at Peak (ht MikeinLongIsland, Brian)

Morgan Stanley ... plans to relinquish five San Francisco office buildings to its lender two years after purchasing them from Blackstone Group LP near the top of the market.

“This isn’t a default or foreclosure situation,” [Alyson Barnes, a Morgan Stanley spokeswoman] said. “We are going to give them the properties to get out of the loan obligation.”
The Morgan Stanley buildings may have lost as much as 50 percent since the purchase ...
Note that Morgan Stanley is current on the loan and is not in foreclosure. They are simply "walking away" because the buildings are worth less than the amount owed.

On residential, the WSJ has an article: Debtor's Dilemma: Pay the Mortgage or Walk Away? (ht Sabine). The article contains a graph of "strategic defaults" by state - however I'm not sure how this is estimated. In very few cases does the borrower admit they can afford the payments and are just walking away (like Morgan Stanley above). In most cases the borrower either doesn't respond or says they are having a financial crisis.

From a research paper earlier this year on homeowners with negative equity walking away: Moral and Social Constraints to Strategic Default on Mortgages by Guiso, Sapienza and Zingales.
It is difficult to study the strategic default decision, because it is de facto an unobservable event. While we do observe defaults, we cannot observe whether a default is strategic. Strategic defaulters have all the incentives to disguise themselves as people who cannot afford to pay and so they will appear as non strategic defaulters in all the data.
The researchers argued that the pace of strategic defaults is increasing - and that is terrifying for lenders.

This is what I wrote in 2007:
One of the greatest fears for lenders (and investors in mortgage backed securities) is that it will become socially acceptable for upside down middle class Americans to walk away from their homes.
And that remains the greatest fear - and it probably doesn't help that companies like Morgan Stanley are walking away from commercial buildings. As the researchers noted, the more people hear about strategic defaults, the more willing they are to walk away. Zingales was quoted in the WSJ earlier this year:
“Our research showed there is a multiplication effect, where the social pressure not to default is weakened when homeowners live in areas of high frequency of foreclosures or know others who defaulted strategically”
I wonder if hearing about "rich" banks that are paying "large" bonuses walking away from commercial buildings also weakens the social pressure?